CASE Network Report 36 - Rational Pension Supervision.First Experiencies of Central and Eastern European States in Comparison with Other Countries

S t a n i s ³ a w a G o l i n o w s k a
P i o t r K u r o w s k i ( e d s . )
Rational Pension Supervision
First Experiences of Central and Eastern European States
in Comparison with Other Countries
W a r s a w , 2 0 0 0 No 36

The views and opinions expressed in this publication reflect
Authors’ point of view and not necessarily those of CASE.
This paper was prepared for the research project No. 98-
158-33, titled Private Pension Funds: Balancing Operational
Principles with Prudent Supervision, financed by the Freedom
House, Hungary, and co-ordinated by the Lithuanian Free
Market Institute
The publication of this paper was financed by the Freedom
House.
Translator: Joanna Dutkiewicz
English Editor: John Edmondson
DTP: CeDeWu – Centrum Doradztwa i Wydawnictw
”Multi-Press” Sp. z o.o.
Graphic Design – Agnieszka Natalia Bury
© CASE – Center for Social and Economic Research,
Warsaw 2000
All rights reserved. No part of this publication may be
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form or by any means, without prior permission in writing
from the author and the CASE Foundation.
ISSN 1506-1647 ISBN 83-7178-214-4
Publisher:
CASE – Center for Social and Economic Research
ul. Sienkiewicza 12, 00-944 Warsaw, Poland
e-mail: case@case.com.pl
http://www.case.com.pl

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Contents
Introduction: Goals and Subject Matter of the Report . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .6
Part I. Analysis of Risks Related to Pension Funds’ Operations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .8
1.1. External Risks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .8
1.2. Internal Risks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .10
1.3. Ranking of Identified Risks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .12
Part 2. Instruments Safeguarding Against the Appearance of Risks in the Operations
of Pension Funds . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .14
Part 3. Dilemmas Related to Sound Pension Fund Operation and Types of Supervision . . . . . . . . . .16
Part 4. Balanced Supervision of Pension Funds . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .18
Part 5. The Practice of Supervision Applied in Other Countries . . . . . . . . . . . . . . . . . . . . . . . . . . . .21
Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .21
5.1. Experiences of Latin American Countries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .21
5.2. Experiences of Selected OECD Countries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .25
5.3. Conclusions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .34
Part 6. Development of Pension Funds and Pension Supervision in Central and Eastern Europe . . .35
6.1. The Development of Pension Funds in Central and Eastern Europe . . . . . . . . . . . . . . . . . . . . . . . . . . . . .35
6.2. The Case of Hungary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .36
6.3. The Case of Poland . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .38
6.4. The Case of Croatia . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .55
6.5. The Case of Bulgaria . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .58
6.6. The Case of Lithuania . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .60
CASE Reports No. 36

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Stanis³awa Golinowska, Piotr Kurowski (eds.)
Conclusions and Recommendations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .65
Appendix.
Legal Provisions Regarding the Supervision of Pension Funds in Selected Countries
of Central and Eastern Europe . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .67
A-1. The case of Hungary: Act on Private Pensions and Private Pension Funds (Act LXXXII of 1997)
[fragments] . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .67
A-2. The case of Poland: Act on the Organisation and Operation of Pension Funds, passed on 28 August 1997
[fragments] . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .72
A-3. The case of Bulgaria: Supplementary Voluntary Pension Insurance Act, passed on 7 July 1999
[fragments] . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .74
A-4. The case of Lithuania: Pension Funds Act, passed in May 1999 [fragments] . . . . . . . . . . . . . . . . . . . . . . . .77
A-5. The case of Estonia: Pension Funds Act, passed on 10 June 1998 (RT * I 1998, 61,979) [fragments] . . . . .78
References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .83
CASE Reports No. 36

The author is Professor of Economics and member of the Council of CASE - the Center for Social and Economic
Research. She is a well-known specialist in social policy and labour economics in the transition countries and possesses
extensive knowledge of the new Polish pension scheme. She has participated in numerous international research projects
inculding UNDP, ICDC UNICEF, European Commission, ACE Phare, GTZ, HIID, USAID.
She is author of many books, over two hundred research papers in the filed of income distribution, effectiveness of
The author is a graduate (1996) of the Faculty of Economics at the Cracow School of Economics, where he was also an
assistant at the Chair of Finance. Since 1997 he works as an assistant in the Department of Social Policy at the Institute of
Labour and Social Studies in Warsaw. The author carries out research in reforms of the pension system in Poland. As a co-worked
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Stanis³awa Golinowska
social policy and labour economics.
Piotr Kurowski
of CASE he is involved in research projects regarding pension systems in Central and Eastern Europe.
CASE Reports No. 36

6
New financial institutions, pension funds, are being
established in Central and Eastern Europe, that are also an
important element of the social security system. They pro-vide
an additional source of income in old age. This source
is all the more important insofar as public, pay-as-you-go
pension systems in many countries are having problems with
meeting previous pension commitments, which were often
excessively generous and did not take into account potential
changes in demographic conditions and the labour market.
Pension funds are primarily business entities whose
financial success brings benefits to their participants – future
old-age pensioners. At the same time, though, these are
social institutions, as they contribute to securing income in a
socially difficult situation – for old age. Their goals thus
include both high effectiveness, leading to the increase of
invested premiums so that these provide income whose
growth rate would not be lower than the rate of wage
growth, coupled with a high level of operational safety to
make sure that future benefits can be paid at a level ensur-ing,
at least, that the real value of invested premiums is
maintained.
Pension funds work simultaneously towards the two
goals – economic and social – and these goals are inter-linked.
Success in achieving the economic goal increases
pensioners’ future incomes, and the security of attaining an
appropriate level is achieved automatically. On the other
hand, relentless striving for a high rate of return carries a
risk factor. The highest indices are achieved on the most
risky investments. However, regulation of the funds’ opera-tions
in the name of their safety limits the chances for attain-ing
higher returns – not only because investment freedom is
limited, but also because safety instruments are costly and
reduce the amount of resources possible to invest. Recon-ciliation
of the two goals of pension funds, the economic and
the social, is therefore a difficult problem requiring great
competence.
Societies in Central and Eastern Europe are very sensi-tive
to the issue of the operational safety of new financial
institutions, and especially pension funds. One can still
observe mistrust of capitalist institutions, while initial expe-rience
with private entities such as banks, savings societies
and insurance companies has not always been positive. In
this situation, ensuring safety by introducing a whole arsenal
of security and guarantee regulations together with the reg-ulations
on establishing funds becomes a political goal that
conditions the very passing of laws on private pension funds.
The subject of our consideration will be the experiences
relating to pension fund regulations from the point of view
of their safety of operations in five countries of Central and
Eastern Europe. These countries represent two groups.
The first includes Hungary and Poland, where the deci-sion
to establish pension funds was made earlier on. Thus,
they can now share their own, though modest, experience,
especially Hungary. Moreover, the debate in both countries
was very extensive and heated [Ferge, 1998; Golinows-ka/
Hausner, 1998]. The second group includes Bulgaria,
Estonia and Lithuania, the countries that passed laws on
pension funds in 1999. In this period, it was the issue of
introducing regulations on the safety of operations and on
guaranteeing a specified level of benefits from pension funds
that was extremely relevant.
In analysing the socially safe functioning of pension funds,
special attention has been devoted to institutions supervis-ing
the pension funds.
The present work was developed in the following order.
The first step involved the identification of risks and their
ranking according to the degree of danger (cf. Part 1). In the
second chapter we discuss the instruments for safeguarding
against and reducing the appearance of risk. For these
instruments, it was important to define them, as well as to
analyse the legal regulations, administrative standards, finan-cial
management standards, codes of ethics, the formula and
competence of supervisory institutions, and the working of
the market. Before presenting the principles and means of
balanced supervision over pension funds, in Part 3 we have
pointed out the basic dilemmas of achieving a balance
between economic and social goals. Next, we have
attempted to show the proper balance between regulatory
instruments and self-regulation in order to achieve a fund’s
balanced operations in terms of both effectiveness and safe-ty
(cf. Part 4).
CASE Reports No. 36
Introduction:
Goals and Subject Matter of the Report

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The fifth part of the report shows the practical experi-ence
of other countries, including those with much more
experience in this area than can be found in Central and
Eastern Europe. Taking into account the history of pension
funds’ development in these countries, we observe two
roads of development of safety institutions.
One way is to establish these institutions ex post. First,
funds were established, without any special supervisory reg-ulations,
and operated for many years without any distur-bances,
or with only minor ones, until a large-scale scandal
emerged. As a consequence, regulations were created to
prevent excessive risks. In the United States in the 1970s,
there was the ERISA package of regulations, and in the Unit-ed
Kingdom a dozen or so years later, after the scandal with
Robert Maxwell’s pension funds, the Good’s Commission
was established which went on to prepare a proposal for
supervision.
The second way involves establishing supervision ex
ante, at the same time as the regulations on pension funds.
This solution is characteristic of the Latin American coun-tries,
which undertook pension reforms in the 1980s and
1990s, introducing a capital pillar. The countries of Central
and Eastern Europe are also undertaking safeguard regula-tions
ex ante.
CASE Reports No. 36
The ex ante road is more difficult insofar as one has to
be able to identify any potential threats to the funds’ safe
operation and have a good knowledge of the various instru-ments
(preventing dangers) and their functioning in a bal-anced
way from the point of view of reconciling effective-ness
with social goals.
The last chapter presents the modest experiences of
five Central and Eastern European states. The report ends
with conclusions and recommendations, while the extracts
of law on supervision over pension funds are cited in the
appendix.
The project was conducted in co-operation with three
research teams from partner institutions:
1. Audrone Morkuniene, Elena Leontieva, Aneta
Lomovska (the project co-ordinator), from the Lithuanian
Free Market Institute (LMFI), Lithuania.
2. Maria Prohaska, Ivaylo Nikolov, from the Center for
the Study of Democracy, Bulgaria.
3. Ramil Pärdi, the Jaan Tonisson Institute, Estonia.
We are grateful for all the participants of the project for
sending us their materials, most of which are included in this
report.

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Part 1
Analysis of Risks Related to Pension Funds’ Operations
CASE Reports No. 36
The risks related to the functioning of pension funds will
be analysed from the point of view of a participant in the
new system – the future recipient of benefits [1]. We
assume that a risk is the probability of the emergence of a
situation in which the value of assets (collected premiums
and profits from investing them) on an individual pension
account is lower than the optimal level possible to attain.
The appearance of a risk results in the loss of real – due to
the drop in real value – and potential income of the benefit
recipient, and its appearance depends on various factors.
The broader the definition of risks, the more factors there
are involved. To identify risks, it is useful to divide them into
internal risks, which can be counteracted by a given fund,
and external risks, which the fund may be threatened by,
regardless of its actions [2].
The term "pension fund" used subsequently in the paper
denotes both an organisation managing the assets gathered
in the fund (in Polish terminology called a pension society)
and the fund itself, meaning the gathered assets, unless
issues are discussed that require the two to be precisely dif-ferentiated.
1.1. External Risks
Analysing external risks against which a fund is unable to
work out the proper safeguards, the following risk factors
can be mentioned:
– weaknesses of reform implementation,
– political pressure on the investment decisions of pen-sion
funds,
– weakness of legal regulations, including the lack of
supervisory bodies or their badly defined role,
– weakness of the pension system’s partners,
– underdeveloped capital markets,
– risk of interest rate changes,
– risk of foreign exchange rate changes, and
– risk of inflation.
Weaknesses in the implementation of pension reform
carry the danger of deviations from the programmed
pension system model that has been approved. This risk
may be caused by pressure from certain groups of interest.
If the public authorities are unable to resist that pressure,
the initial rules are abandoned and new ones introduced.
One example of applying pressure to change the approved
solutions in Poland involves demands to abandon the invest-ment
limits in force, and demands to introduce tax-related
benefits for organising the "third pillar" and participating in
it. When joining a fund is voluntary, tax-related benefits can
have a strong impact on increasing the motivation to partic-ipate.
Another source of deviations from the approved pen-sion
model can involve changed political set-up as a
result of elections. This risk consists in generating new
legal regulations as a result of implementing different ideo-logical
concepts, as well as the policymakers’ striving for
short-term goals, e.g. resulting from a heavy budget deficit.
Though political risk is much greater in public pay-as-you-go
systems [3], it can also occur in the privately managed sec-tion
(of the pension system). In such cases, it is very impor-tant
to agree on the draft with the political opposition
before it becomes the subject of a parliamentary debate.
Deviation from the approved model of changes and
political pressure on the funds’ investment decisions are
dangerous external risks. On the one hand, they may seri-ously
shake social trust in the proposed reforms, while on
the other, such changes obviously arouse the distrust of pri-vate
organisations interested in taking part in pension fund
[1] It is possible to analyse the risk in other distinctions than, as proposed here, in dychotomic approach: the pension fund as the financial institu-tion
versus its members. For example, Turner (1996) proposes the analysis of risk bearing between pension fund, its sponsors, workers, employer and
government.
[2] Other approaches are also widely used. The risk in pension plans can be considered in three market areas: labour market, financial market, and
political market. Cf. Turner (1996).
[3] It is worth noting the great effort required for all the political forces and social partners to achieve a compromise when passing the law on pen-sion
funds in Poland [cf. Golinowska, Hausner, 1998].

9
management. Changes made during implementation may
also increase the cost of the new system.
The next important external factor is the lack of cohe-sive
legal regulations for pension funds, in particular the
improperly defined role of supervisory bodies.
First of all, the new institution of the pension system
may be badly placed in the existing system of supervisory
organisations. If the supervisory organisation is separate i.e.
only for pension funds, an unclear division of competence
between it and existing organisations for supervising other
players on the financial market is possible. Situations of
under-regulation may appear, for instance if the new super-visory
body’s range of competence does not include invest-ment
processes, while the Securities Commission – estab-lished
for such a purpose – considers itself relieved of the
duty of supervising pension funds in this respect. Another
example of vagueness in this area that is currently apparent
in Poland is supervision of employee pension programmes.
Wherever the form of the pension system’s third pillar is
not an employee fund, then apart from the Office for Pen-sion
Fund Supervision (UNFE), there are two institutions
that can be authorised to supervise pension programmes.
These are the State Office for Insurance Supervision,
because these are life-insurance based programmes; and
the Securities and Exchanges Commission, because these
are investment-type programmes assigned to trust funds.
Secondly, dangerous situations can occur as a result of
the excessive "openness" of supervision regulation,
namely in assigning an important role to supervisory bodies’
discretionary decisions, and/or accepting vague (insufficient-ly
specified) rules of action towards the funds. In the coun-tries
undergoing transformation it is especially important to
define precisely the rules for division of responsibilities and
to develop clear procedures. It seems that in a situation of
lack of experience and lack of systematic standards of
behaviour, under-regulation can be more dangerous than
excessive regulation. Moreover, in cases of under-regula-tion,
there is too much room for political pressuring and
political decision-making.
Another area of potential danger for pension funds
could be the weakness of partners operating in the
whole pension system. The issue here is the lack of co-ordinated
actions among institutions regulating and adminis-trating
the whole pension system, in both the public and pri-vate
sectors. The weaknesses in the pension system’s pub-lic
part may result mainly from insufficient adaptation behav-iour
in situations when unexpected trends appear [4]. Lack
of preparedness for the possibility of difficult and unexpect-ed
CASE Reports No. 36
situations leads to tension and undermines social trust in
the new system. In Poland, this risk appeared following
technical problems on the part of the Social Insurance
Company (ZUS) (the public pension institution) with trans-ferring
premiums to private pension funds [cf. Skrobisz,
1999].
In the area of private fund management companies, the
weakness may involve a tendency towards institutional oli-gopoly,
which leads to a lack of healthy competitive
behaviour under conditions of high barriers to entering the
retirement benefit market. This risk can appear especially at
a later period, after the pension fund market structure
forms and strengthens, when the fight for customers weak-ens.
The lack of competitive behaviour can also occur due
to over-regulation of the funds’ operations, e.g. through the
requirement for a minimum rate of return. Being long-term
savings organisations, pension funds can occasionally record
lower profitability than the required minimum for the whole
system. In a situation where the deficit is to be financed
from the assets of the management company, pension funds
– fearing infringement of their assets – often give up their
own long-term investment policy in favour of copying the
leaders.
One factor that effectively restricts pension fund man-agement
is under-development of the capital market.
This factor is especially important in the emerging markets,
which are undertaking to build new market institutions as
part of the transformation process. The experience of other
countries, such as Chile, shows that pension funds can con-tribute
to the development of those markets, but on the
condition that the market is prepared for absorbing a signif-icant
demand for financial instruments [5].
Good functioning is conditioned by the proper scale of
absorptiveness of the domestic capital market.
Experts estimate that in Poland, given the present state and
dynamics of development, the capital market will be able to
absorb the funds’ demand for securities in stock-exchange
trade for the next two to three years. It is very likely, how-ever,
that later on, in a situation where the number of avail-able
financial instruments is limited, pension funds will be
unable to invest effectively due to both the market’s limited
size and the fixed portfolio structure (limits on investing in a
given instrument).
The capital market’s development could be hampered not only
by the insufficient rate of privatisation but also due to the lack of reg-ulation
of some areas of the market. One example of such a draw-back
in Poland is the market for public trading of debt securities,
and corporate and municipal ones in particular [Koz³owski, 1999].
[4] In Hungary, excessive criticism of the old solutions caused the population to move towards private funds to a much greater degree than expect-ed.
This trend also appeared in Poland despite the greater level of safeguarding against it. In Kazakstan, participation in capital funds was made obliga-tory
for all insured persons, regardless of the fact that such a decision is simply unprofitable for people with a longer period of being insured.
[5] Vittas (1999) argues that if pension funds operate in a conductive regulatory framework, they have a beneficial interference on financial market
development.

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CASE Reports No. 36
Areas that require proper market standardisation and
regulation for pension funds to be able to invest in them
include public infrastructure and real estate. Until there
appears the possibility of daily valuation of securities from
those markets (debt securities, debenture bonds, etc.),
pension funds will be unable to invest in them. In the case
of the real estate market, as yet unresolved ownership
issues are an additional difficulty delaying its regulation.
The under-development of the capital market is also
linked to lack of stability. No one needs convincing as to the
existence of this risk. Sudden changes in the prices of assets
undermine investment strategies.
The next external risk is the possibility of a downward
business cycle. Market analyses using different methods
and assumptions aim to minimise the risk of wrong deci-sions,
including those related to movement of share prices
on the stock exchange. However, this risk cannot be elimi-nated
completely.
The same is true for the risk of foreign exchange rate
changes (investments in foreign securities) and for the risk
of interest rate changes (investments in debt securities).
These risks are external elements that are an inseparable
feature of the investment process. One of the possible
strategies for limiting these risks is to purchase certain deriv-ative
instruments. However, this kind of safeguard is only
just forming on "young" capital markets. Decision-making in
the emerging markets thus carries a higher risk than on
developed capital markets.
Inflation is an important risk that carries substantial
weight in Central and Eastern European post-communist
countries. When inflation is high (a two-digit figure), a
rational and safe investment policy is seriously threat-ened.
In Poland, the single-digit scope of inflation (since
1998) enabled private companies to enter the "pension
industry". It should be noted that in the first half of the
1990s, in spite of serious discussions of experts on pen-sion
reform, private financial institutions could not be
counted on to get involved. This was mainly due to the
high inflation risk, which at that time was the greatest
barrier for private organisations’ participation in the new
system.
1.2. Internal Risks
There are three main areas of pension funds’ operations
where internal risks may occur, and these shall be analysed
here.
They are:
1) administrative (fund management),
2) social (rights of fund members), and
3) business operations.
1.2.1. Administrative Risks
Administrative risk concerns the organisation managing
the fund (the pension society). The risk may involve the
inability for conscientious and effective management of the
entrusted funds.
Inadequate administration of a pension fund’s resources
can be due to several factors. It may occur due to the man-agement
personnel’s low qualifications. With insuffi-cient
competence, especially in financial management, it is
hard to make accurate and sensible decisions.
The condition involving high qualifications is also related
to the issue of division of competence in the society’s
management board. The division of tasks and responsibil-ity
should be clear and specific. This is made possible by,
among other things, internal decision-making procedures
(by-laws) leading to individual responsibility.
Another threat to the funds’ effective operations can be
a functional imbalance between actions for the bene-fit
of shareholders and those for the benefit of fund
participants. The pension society board has its clients –
fund members – on the one hand, but it also represents the
interests of the shareholders – founders of the society. The
latter may pressure the board to invest the fund’s resources
in projects related to their own business operations. This
kind of pressure may lead to engaging resources in projects
that do not bring profits to the fund’s participants, while
being a cheap source of capital for the society’s founders. If
a pension society’s board succumbs to pressuring, this will
be the beginning of unjustified transfers of assets between
the pension fund and the administrating company, or
between different programmes for different groups of par-ticipants.
Other potential risks threatening the interests of insured
persons might involve management take-over processes
and pension society consolidation, and finally the announce-ment
of a society’s bankruptcy.
Moreover, the administration process may lack stan-dards
concerning financial matters, such standards that are
usually followed by institutions wanting to be perceived as
professional businesses. This risk could involve improperly
prepared financial reports and inadequate bookkeeping.
When such standards exist, the problem may lie in the fund
board’s capacity to comply with them. Inadequacies in this
respect may lead to erroneous decisions, while on the other
hand, the fund’s financial situation can be purposely distort-ed
in the report system.
1.2.2. Social Risks
Social risks include endangering the rights of insured per-sons
in terms of participating in a fund or the worsening of
conditions of obtaining benefits. Social risks are not uniform.

11
Violation of the interests of insured persons can have a vari-ety
of aspects.
Firstly, the information reaching clients considering join-ing
a pension fund may be distorted. When wanting to
decide whether to participate, potential members of capital
funds are entitled to complete and reliable knowledge of
their rights and possible alternatives. Clear and honest infor-mation
should be provided both by the mass media and by
the person dealing with direct sales of retirement ser-vices
(the pension fund’s salesperson). Information provid-ed
by the media should not be misleading and should not
refer to other alternatives (funds) in the form of a negative
campaign. The key element, however, is a face-to-face
meeting between the client and the fund’s salesperson. Due
to the large degree of complexity of a pension fund’s func-tioning,
prospective clients often have to rely on the sales-person’s
knowledge and advice. A salesperson, on the other
hand, may persuade clients to join the fund without having
their genuine interests at heart. This occurs, for instance,
when a commission-based motivation system that focuses
only on signing up new members is used with salespeople.
If, in addition, a salesperson is attached only briefly to the
pension fund, there exists the possibility of falsifying data on
fund membership.
A risk that can directly strike fund participants is the lack
of standards safeguarding the participants’ interests
when entering into an agreement with the pension
fund. The source of this lies in the asymmetry of informa-tion
between the fund’s agent and the prospective client
concerning possible solutions. The risk appears when the
agreements on pension fund membership are vague or
ambiguous. A person joining a fund may wrongly understand
the agreement’s unclear content, while comparing alterna-tives
when making a choice is difficult if there are no stan-dards
on the contents of agreements.
In the event of a disadvantageous financial situation, a
fund may strive to change the terms of the agreement in
order to reduce participants’ future claims. Thus, social risk
may appear in the way changes are made to the pen-sion
agreement that could be detrimental to the fund’s
members.
Unequal treatment of fund participants may also emerge
in the form of unequal division of income from the
fund’s investments. Invested resources generate an
income whose distribution may turn out to be dispropor-tionate
in relation to each member’s contribution. Then, a
given group of insured persons would gain more from the
income generated by investment than others.
Equally important are limitations related to switching
fund membership. We know from experience that unlimit-ed
CASE Reports No. 36
client freedom leads to high administration costs due to
a high rate of insured persons’ fluctuation. Restrictions for
participants should be minimised, however, and should be as
uniform as possible for all the funds.
In a fund that not only increases the resources obtained
from premiums but also pays out benefits once members
reach retirement age, there is the possibility of the risk of
paying out lower benefits in a given fund compared to
others. The social risk lies in the fact that a fund participant
comparing the benefits received by other persons with sim-ilar
social status and a similar pre-retirement career may
consider their own pension to be too low. Of course the
sources of this type of danger are found in other areas,
mainly in the level of fund management costs or investment
policy effectiveness. One should remember, though, that if
such remissness is excessive, this could lead to a strong
social reaction expressed in a sense of losing out in relation
to other benefit recipients from the private system.
1.2.3. Risks Related to the Fund’s Business
Operations
In analysing the economic aspects of risk, we will
focus on the following two areas:
1) the investment process,
2) the fund’s day-to-day operations.
Investment risk stems from the nature of a pension
fund’s operations, consisting in increasing the collected
resources in the long term [6]. Obviously, in view of chang-ing
market conditions, investment operations of any organi-sation
on the capital market carry a risk.
The primary risk in the investment process is a fund’s
low profitability, which means the fund has not worked
out the optimal profitability rate that it is possible to attain
under a given set of conditions. It should be noted that we
are talking about optimal profitability, namely that which is
possible in the current market situation.
Another approach involves relative profitability – com-pared
to other funds. Leaving aside the criterion of evalua-tion
here, this risk means that a fund generates lower
income than is possible to achieve.
Errors in managing a pension fund’s resources may result
from, for example, the lack of professional market
analyses. Here again we touch on the issue of suitably high
qualifications, which are essential in fund management. A
bad or incomplete analysis of the market and the appropri-ate
instruments may lead to another threat, namely an inap-propriate
investment strategy. Diversification of the
investment portfolio for a given rate of return may be
[6] According to Turner (1996), the capital market risks are grouped in the following groups: financial market risk, risk due to malfeasance, infla-tion
risk, interest rate risk, risk due to the financial performance of the plan sponsor.

12
CASE Reports No. 36
both too "risky" (when the risk is underestimated) or too
conservative (when the estimated risk is greater than the
real risk). The issue here is on what scale the pension funds
will invest in company shares, and what part will be invest-ed
in debt instruments.
It is worth noting that the reference point in risk diver-sification
comprises not only the level of investment risk
but also the period of investment. A fund’s investment
policy should take into consideration the interests of the
fund’s members, which may be mutually exclusive. For a
young employee whose prospects for membership in the
fund span several decades, a policy of greater investment
in shares will be more appropriate. As we know, in devel-oped
capital markets the rate of return on such invest-ments
in the long term is greater than it is on bonds. For
an older person, with a dozen or so years membership,
such portfolio diversification could be too risky, and may
cause a given person to sustain losses due to the possibili-ty
of short-term fluctuations.
The risk of investing in preferred projects or
investments recommended by the shareholders of
the company managing the fund has already been dis-cussed,
but it is worth mentioning here as well, as it is one
of the fundamental dangers that could potentially lead to
low investment effectiveness. One could say that it
includes all the analysed dimensions: economic, social and
administrative.
The last area of risk in investment operations involves
bad management from the point of view of liquidity. In
the investment phase of a fund, the main element of uncer-tainty
is the scale of predicted payments into the fund and
the period of undisturbed inflow of premiums. Maintaining
the proper level of liquidity is more important in the phase
of paying out benefits, which is delineated by the members’
retirement age. Analyses from the point of view of the liq-uidity
criterion are also important for the fund’s investment
policy (purchasing various financial instruments). This is
because such structures of engagement of resources are
possible that limit the flexible introduction of favourable
changes, which in turn reduces the effectiveness of the
investment policy. The purchase of "bad" packages (similar
to "bad debts" in the banking system) can also be detrimen-tal
to liquidity. In the emerging markets, the possibility of
selling inconvenient securities is probably more limited.
As we have mentioned, investment operations are not
the only area where economic risks can occur. A separate
area comprises those factors of day-to-day operations that
have a negative impact on the fund’s financial condition.
Firstly, this can be a vague division of assets between
the society (management company) and the pension
fund. If the fund’s finances are not clearly separated from
the management company’s, shareholders in the pension
society or shareholders in its founding organisations may file
claims on the resources of the pension fund, which is imper-missible.
Such shortcomings may result in the risk of
resources of fund participants being taken over (by
somebody else).
The high costs of fund management, in effect leading
to decreased retirement benefits, can be a dangerous trend.
From the point of view of a pension fund participant, fund
management costs are determined by two factors. The first
is the level of fees and commission received for man-aging
the fund. It seems that in the countries undergoing
transformation, where there is still a deficit of qualifications
in investment advisory services, these costs may lead to a
somewhat high level of administrative fees, despite exten-sive
competition on the retirement services market in its
early period.
The second element that could carry the risk of high
management costs involves external costs, or transfers
made from the pension fund to other financial institutions
for specialist services, e.g. to a bank where the fund’s
resources are deposited or to the company maintaining a
register of fund members. Firstly, services ordered by the
pension society may be performed improperly or incom-pletely,
which increases costs and has a negative impact
on the fund’s profitability. Secondly, the transfer of
resources could be disproportionate in relation to the
cost of the services.
The final risk in day-to-day operations comprises weak-nesses
in the proper valuation of assets. The value of
assets, and especially the value of a participation unit in a
pension fund, is one of the important elements taken into
account when choosing a pension fund.
1.3. Ranking of Identified Risks
Though the presented description of risks points to the
main danger areas in the functioning of the funds, it does not
show which of these areas are the most important in the
countries under consideration. That is why experts from the
countries taking part in the study specified such risk groups
using a point method of risk grading.
Each risk area was to be allocated a degree of danger.
For this purpose, a five-degree scale of risk was chosen,
expressed in assigned points, in decreasing order. This
means that "1" marks those areas in the functioning of a pen-sion
fund that carry the greatest risk. Consequently, "5" was
assigned to those risks that are of minimum importance.
Moreover, it was decided that in those areas where the
degree of risk is 4 or 5, there is no need to develop special
remedial measures. On the other hand, in areas where the
degree of risk is higher (1 – 3) a more in-depth analysis will
be necessary, leading to the development of specific safe-guards
(instruments).

13
In the countries covered by the analysis – Bulgaria, Esto-nia,
Lithuania and Poland – the risk most dangerous to the
funds’ functioning was perceived to be the lack of cohesive
legal regulations, and erroneously defined functions of the
supervisory body (1 point). The risk of lack of competitive
behaviour on the part of pension funds was also considered
important, especially in the context of a lack of reliable
information on a fund’s financial situation (2 points). Areas
where the degree of danger was considered moderate (3
points) included under-development of the capital market, a
downward business cycle, and weakness of the financial
institutions providing services to pension funds. The other
groups of external risks, including political risk or instability
of the domestic currency (inflation), were seen to be unim-portant.
In considering the dangers from internal risks, the evalu-ations
are harsher than those described above. This is espe-cially
true for economic operations and members’ rights
(social risks). In economic operations, the areas considered
the most burdened with risk (1 point) are as many as five:
– inappropriate diversification of the portfolio from the
point of view of risk,
– inappropriate diversification of the portfolio from the
point of view of the insured persons’ interests,
– investing in investments suggested by the pension soci-ety’s
(management company’s) shareholders,
– improper valuation of the fund’s assets, and
– ambiguous rules for separating the assets of the soci-ety
from the assets of the pension fund.
The risk of inaccurate analyses and financial planning as
well as the danger of losing financial liquidity (the risk of
investing in difficult-to-sell instruments) was also seen as
highly probably (2 points). A moderate value was given to
two kinds of economic risk: high management costs and for-eign
exchange rate risk (3 points). In the case of Poland, this
last area was the only one given four points among eco-nomic
operations. There was no risk in the economic oper-ations
category that received the lowest mark of five points.
In the social area, or that concerning the rights of per-sons
participating in a pension fund, the most dangerous
areas were: (1) the lack of standards protecting the clients’
interests at the moment of signing the agreement and (2)
the way changes are made to that agreement, which could
lead to losses for the client. The other groups of dangers
(restrictions on switching to another fund and the unequal
distribution of income from investment operations) were
also considered important (2 points). The only exception is
the risk of discriminating against certain social groups in
terms of access to participation in a fund, which was seen as
being moderate. This seems apt, mainly because this kind of
risk is not very probable in countries where the capital pil-lar
of pensions is introduced as an obligatory element.
CASE Reports No. 36
In the area of pension fund management, the experts
thought that the greatest risk was the excessive involve-ment
of the pension society management in operations
other than the functions for the benefit of pension fund
members. Thus, the main danger is pressure on the pension
society management from its shareholders. The other
administrative areas, except the risk of ambiguous division
of tasks and responsibilities, were also assessed as being
dangerous. There were no weak marks (4 or 5 points) in
the group of administrative risks.
One should note that the overall assessment, which
sums up the experts’ evaluations in the analysed countries,
was significantly different in some areas than the view taken
by experts from Poland. This was especially true for assess-ment
of the danger from external risks, where the differ-ences
in evaluation were the greatest. Contrary to the over-all
assessment, most of the external conditions were con-sidered
important in the case of Poland (1 to 2 points).
Apart from bad legal regulations, the factors considered the
most disadvantageous included the public pension system’s
inefficiency and high inflation (1 point). Also considered
"dangerous" are the badly defined role of supervision, the
lack of healthy competition between the funds in winning
clients, under-development of the capital market, and its
instability (2 points). In evaluating the situation in Poland,
there was no external factor that was perceived as being
moderate, while the other groups were seen as unimpor-tant.
For internal risks, the differences were small, not
exceeding one point, and consequently will not be
described in detail.
It seems that the distance in evaluations of external risks
between Poland and the other countries is the effect of
longer experience due to the earlier introduction of pension
reform. Just under a year from the enactment of the main
regulations allowing private pension funds to be established
(from 1 January 1999), a number of shortcomings were
observed in Poland, which will be discussed later (cf. part
7.1. of this report). Among the greatest dangers for the
funds’ functioning in Poland is the lack of flexible action in
the public system. This is an important conclusion from Pol-ish
experience for those countries where the funds are just
beginning to operate and where unpredicted, external
weaknesses of reform have not revealed themselves yet.
The above analysis of risks of pension funds shows how
many factors, both external and within the funds themselves,
can threaten the interests of future benefit recipients. In addi-tion,
taking into account the necessity to gain public trust in
the new pension system institutions, including pension funds,
it is necessary to create a set of solutions that will protect the
funds from the emergence of these risks. These instruments
are particularly important when capital funds appear as an
obligatory part of the reformed pension system.

14
Part 2
Instruments Safeguarding Against the Appearance of Risks
in the Operations of Pension Funds
CASE Reports No. 36
The analysis of potential risks in pension fund opera-tions,
presented in the first chapter, has shown the most
important danger areas for effective operation. These risks
have been presented as potential risks, as they do not have
to emerge if the proper instruments are included in the new
pension system. These instruments’ basic function is to min-imise
the risks of participating in private pension funds. The
issue here is not only about legal safeguards aimed at estab-lishing
state supervision over private pension funds, but also
the development of self-regulation mechanisms.
This part of the report will present the possible, basic
kinds of instruments safeguarding against the emergence of
risks in the functioning of pension funds. These instruments
play a varied role in individual phases of introducing the new
pension system. Some are of key importance at the design
stage of the new pension system model, up to the moment
when the necessary legal regulations are passed, while oth-ers
are important when the new system is started up. Oth-ers
still gain importance with the passage of time as new
solutions consolidate.
Taking into account the as yet modest experience of
pension reform in Central and Eastern European countries,
one can identify the following kinds of instruments that
correspond to the identified risks in pension funds’ opera-tions:
– The first kind of instrument involves education on
securing income for old age. The target of such educa-tion
is both the population as a whole and different groups
of participants in the pension system. Such education in the
countries undergoing transformation plays an important
role in the understanding and acceptance of the system
changes. The aim is to deal with false ideas about the way
old-age pensions are financed, show the need for individual
saving and describe future dangers that giving up the
reforms could lead to. Moreover, thanks to a public debate
on the new institutions – pension funds and the companies
(pension societies) managing them – people are growing
accustomed to new solutions. It is furthermore possible to
gain full social confidence in the new institutions, as well as
social control by introducing solutions correctly.
Equally important is more thorough education of partic-ipants
in the pension system: employers as payers of premi-ums,
employees – represented by trade unions for example,
benefit recipients represented by pensioner organisations,
prospective shareholders in the pension societies managing
the pension funds, and administrators of the public pension
system. One important element is to show both the good
and bad experiences of other countries. These experiences
should be comprehensively demonstrated, with the partici-pation
of experts who, thanks to their personal status and
attitude, are reliable.
It is also important to supply solid knowledge on the
pension systems and reforms to the participants of
the legislative process. Considering both the election
cycle (the fact that legislative authorities have a specified
term in office) and the inertia of previous solutions, espe-cially
in the social area, the reform’s authors need to con-vince
[legislators] of the need to introduce changes, as well
as ensuring these changes are passed. With this aim in mind,
it seems essential to educate both ministry officials, who ini-tiate
new acts of law, and deputies and senators (especially
those working on the acts in the appropriate committees),
so that they respect the logic of the presented draft in their
legislative work and do not succumb to pressure from
groups of interest or to populist demands from certain
employee groups.
The education of the media community, journalists
and columnists who are responsible for the way the new
concepts are presented (to the public) is impossible to
overestimate. This presentation needs to be reliable and
comprehensible. Moreover, it should promote the future
benefits of introducing the reforms – not only the benefits
related to individual pension levels, but also those related to
the stability and solvency of the system as a whole. Good
economic education of the public is the preliminary condi-tion
for the reform’s success. This instrument is most
important in the first phase, when the new pension system
is being designed, and during the process of its passage.
– The public’s education is linked to promotion of the
new system solutions. Promotional activity differs from
social education in that the former is conducted at the sec-ond
stage of reform, when the structure of the new pension
system is already decided. The target of the promotional
activity is broad public opinion, to which the reform pro-

15
gramme is addressed. In most cases this means the working
population. Promotional campaigns can be carried out by
various entities, both public authorities responsible for
reform implementation (in Poland, the Government Repre-sentative
for Social Security Reform) and the Office of
Supervision, as well as the new emergent institutions (pri-vate
pension funds). Thanks to promotion based on solid
information it is possible not only to familiarise people with
the new pension system but also to prepare the funds’
prospective clients for making the decision to participate.
– Another important group of tools safeguarding against
risk includes the developed legal regulations that form
the basis for pension funds’ operations. Legal regulations
make it possible to prevent risks, especially internal ones.
For example, a legal structure of the funds that clearly
separates the fund as the collected assets of its participants
from the pension society as the management company
allows for greater protection of the gathered resources of
fund participants. Also important are the legal require-ments
for prospective fund founders, which usually set
tight conditions for entering the market. The law also speci-fies
the conditions for the management of the funds’ finances
– day-to-day operations, investment activities and so on.
It is important the passed acts of law form a cohesive
whole. This means that the regulations should provide a
good platform for introducing the pension funds into the
existing legal and economic system. It is worth adding that
developing cohesive laws is a dynamic process and will be
especially intensive in the reform’s initial period. It will not
lose importance later, though, because regulations require
continuous adaptation to new situations.
– Once acts of law have been passed, there comes the
important process of forming new pension system insti-tutions.
In Central European countries, the supervisory
body is usually established first, and then the pension funds.
When establishing the supervisory body, the important
issue is whether it will be a specialised body supervising only
the retirement services market, or linked to supervision
over the whole financial services sector. It is also important
whether or not the supervisory body is politically and finan-cially
independent, namely to which institution it is
responsible to for its actions, and what the sources are of
its budget revenue. A certain role is also played by the
procedure of the supervisory body in obtaining its regu-lations
from its superior organisation, and the election
CASE Reports No. 36
method (the appointment of the supervisory body’s
chairman).
When establishing pension funds, one essential process
is that of obtaining a licence for the pension society manag-ing
the pension fund and registering the funds in the appro-priate
registers.
– The nature of the control and supervision over the
whole pension fund system by a specialised institution
is determined mainly by the legal regulations, which give
that body the appropriate competence. However, the prac-tice
and effectiveness of supervision is also influenced by
other factors, including the pension funds’ capacity for rep-resenting
their interests.
Polish experiences show that besides the operation of
pension funds, the other important area for supervision is
the system’s public segment. Supervision over the public
system is especially important when it is responsible for col-lecting
the whole of the premium and transferring the
appropriate share to the funds.
– Developing professional and ethical operational
standards. Besides complying with existing laws, the pen-sion
funds develop their own standards of conduct, which
may be accepted and obeyed by all the market players. In
civilised market economies, various procedures or rules of
conduct (for accounting or customer service) are obvious
and are obeyed – these are standards developed from years
of experience. The funds will usually comply with them
because they want to be perceived as professional institu-tions.
In the countries undergoing transformation, however,
many standards of conduct do not function yet, likewise
even in the area of pension funds.
– Self-regulation in areas of healthily competitive
behaviour. It can be expected that in specified situations,
competition among the funds in order to gain clients will act
as an instrument safeguarding against risks. This is especial-ly
true of the period of promoting new solutions, when
most people to whom the reform programme is addressed
will be deciding about joining a pension fund.
However, taking into account that the market for pri-vate
pensions is a market with tight entrance restrictions,
there may appear trends towards oligopolistic behaviour,
neglecting the interest of fund members. This can occur
particularly in the latter period. Restrictions on switching to
a different pension fund can lead to this.

16
Part 3
Dilemmas Related to Sound Pension Fund Operation
and Types of Supervision
The instruments, or tools, presented in the previous
chapter form general guidelines. They are far from a
ready-to-use arrangement for a specific country. The
appropriateness and effectiveness of specific solutions
largely depends on factors that characterise a given coun-try’s
situation: its level of economic development, the
population’s affluence, traditions of business culture and
co-operation, etc. The safe and effective operation of
pension funds in a given country requires a proper set of
tools that do not necessarily have to be universal, but
whose deviation from the general rules should not be so
numerous as to change the basic mechanism of the instru-ments’
functioning. And if these deviations do occur, they
should be rationally justified.
When constructing these instruments, the legislator
faces many dilemmas. These may result from the contradic-tion
between the goals of the system’s new institutions and
the tasks of the instruments used to safeguard against risks.
We have identified the following dilemmas that need to be
resolved in order to ensure a sound basis for the funds’ func-tioning:
– The first dilemma involves the conflict between
social goals and effectiveness goals. For private pen-sion
funds, the main criterion of operation is effective-ness
aimed at achieving the optimal rate of growth of
invested resources under given conditions. This does
involve a risk, however. For the state, on the other hand,
the funds’ safety and stability is important, due to the
desired social acceptance of the reform. Administrative
or legal limitations – most often used towards investment
policies – mean that the scale of operations is limited,
which reduces in turn the funds’ profitability. This price is
much higher when the capital pillar is obligatory, because
then, as mentioned above, supervision by the state is
stricter.
– The second issue concerns the character of pension
fund supervision. Taking into account the experiences of
other countries, two models can be identified. Supervision
over the funds can be reactive, when it acts in emergency
situations and assumes greater independence of operation
for the funds. One can say that it emphasises a more spon-taneous
development of the pension sector. Active super-vision,
on the other hand, anticipates any serious deviations
on the part of the funds and undertakes day-by-day moni-toring
of practically all the fund’s actions. In this option, the
scope of regulation is broader, and we observe strong pre-rogatives
for the supervising body.
The countries undergoing transformation may be
encouraged to use the active model due to the lack of stan-dards
for administrative procedures and financial manage-ment,
as well as the lack of ethical standards of conduct (e.g.
a code of ethics for customer service). The reactive option,
on the other hand, can be supported by the argument of
ethical, i.e. careful, treatment of the developing, early retire-ment
market, which could be "suffocated" by inflexible legal
regulations hampering its development.
– One of the key elements for effective operation of
pension funds is the nature of relations between pri-vate
pension funds and the supervisory body. In prac-tice,
let us mention two possible variations of co-opera-tion.
The first involves close co-operation in taking up dis-putable
issues and reaching a joint position. The second
scenario assumes a conflict of interests and methods of
operation. The pension societies, through their represen-tatives,
develop an alternative position and make use of
lobbying (in parliament, for instance) to force through
their own solutions. It seems that the former scenario
ensures to a greater degree that operations will be safe
and more effective.
– Also important is how the relations develop between
funds themselves, especially in competing for participants.
This is expressed in the way they carry out advertising
campaigns. It seems there are two optional modes of
action. The first involves honest and rational competition,
with reliable information on the terms of participation in a
fund, the financial results and management costs. The sec-ond
possible option involves ‘unethical’ competition, intro-ducing
aggressive means of persuasion, without offering full
information, and showing other funds in a negative light. As
we mentioned above, a fund’s promotion should be carried
out in a rational way.
– Another problem for funds’ efficient operation is the
nature of the financial policy implemented. Should it be
bolder and more risky, which means engaging the portfolio
CASE Reports No. 36

17
more seriously in publicly traded shares, for instance, or
should it be a conservative policy investing most of the
resources in state debt securities?
– The previous issue is also linked to the range of
possible investments in foreign securities. This is not
just a technical problem. In stable Western markets the
investment risk is much lower than on the undeveloped
markets in the countries undergoing transformation. Thus
it is in the interest of the new system’s participants to have
the majority of a fund’s resources engaged in securities
issued abroad. However, pension funds are a stimulator of
the domestic capital market’s development and of the
level of investments in the economy. That is why the pub-lic
authorities will work towards limiting investments
abroad in the interest of the economy and to stimulate the
development of the domestic capital market. Which is
more important: the interests of insured persons, or
the interest of the economy as a whole? This dilemma
is pointed out by Nikolas Barr in his analysis of the reforms
undertaken in the countries of Central and Eastern Europe
[Barr, 1999].
CASE Reports No. 36

18
Previously, we considered the areas where risks appear
in pension funds and what instruments can be used to coun-teract
those risks. In this chapter we shall attempt to answer
the question: What instruments can be used to counteract
CASE Reports No. 36
Part 4
Balanced Supervision of Pension Funds
Table 4.1. External risks and instruments in the functioning of pension funds
Risks Instruments
Weaknesses in reform implementation Social education of experts, politicians and mass media
Political pressure on the funds’ investment decisions Systemic and legal solutions separating politics from
business
Weakness of legal regulations in force, the lack of
supervisory bodies or their badly defined role
Educating policy-makers
Information about solutions used in other countries
Taking into account the possibility of the supervisory
body undertaking legislative initiatives
Amending regulations aimed at effective supervision
Weakness of institutions administrating the pension
system, including the public sector (ZUS)
Legal regulations
Integral supervision over the pension system
Weakness of institutions in the financial sector (the
depository bank, other institutions)
Legal regulations
Business ethics
Supervision of the financial sector
Under-development of capital markets Consistent privatisation
Developing new financial instruments
Risk of interest rate changes Developing new financial instruments
Risk of foreign exchange changes Consistent anti-inflation policy and good
High inflation macroeconomic policies
Table 4.2. Risks and instruments in the administrative area of pension funds
Risks Instruments
Low management personnel qualifications leading to
bad management
Requirement for the proper managerial qualifications in
the licensing process
Supervisory action
Unclear division of competence Requirement for internal division of responsibilities
Professional standards of conduct for the funds
Functional imbalance between actions benefiting
pension society shareholders and fund participants
Regulations safeguarding against conflicts of function
Requirement of the clear separation of the assets of the
fund and the society (management company)
Supervisory actions of a state institution
Improper accounting and/or weaknesses in enforcing
existing standards
A framework chart of accounts specified by law
Professional standards of conduct for the funds
Independent audit

19
effectively the risks to pension funds’ functioning, while tak-ing
care not to stifle the funds’ proactive and effective
behaviour with excessive regulations and supervision?
Each group of risks has been analysed separately and the
appropriate tools for combating them have been listed.
Let us start by analysing the external risks. It seems that
in most cases, elements of social education and the devel-opment
of good and cohesive legal regulations will be good
instruments (cf. Table 4.1). Educating experts and politicians
can prevent political risk, and help in developing efficient
solutions and a well-placed role for state supervision over
the funds. The key element will involve skilfully using the
experience of other countries and developing one’s own
model of changes.
The risk of administrators’ weaknesses damaging the
pension fund system can be avoided thanks to good regula-tions,
including those that guarantee efficient supervision
over the public sector institution and the organisation that
Table 4.3. Risks and instruments in the social functioning of pension funds
CASE Reports No. 36
Risks Instruments
Inadequate or untrue information about the terms of
participating in a fund
Educating salespersons
Requirement of qualifications confirmed by an exam
The possibility of clients’ filing complaints against a fund
Professional standards of conduct
Code of ethics
Lack of standards safeguarding the interests of
participants when signing an agreement with a pension
fund
Educating the shareholders
Code of ethics
Methods of changing the terms of the agreement
undefined or defined to the participant’s detriment
Requirement of access to information on the financial
consequences to the participant of the proposed changes
The possibility of filing a complaint to the supervisory
body against the fund’s functioning
Limitations on switching funds Regulations ensuring the possibility of leaving a fund
The possibility of filing a complaint against the fund’s
functioning to the supervisory body
Discriminating against or in favour of specified groups
of participants
Requirement of criteria of participation defined by law
The possibility of filing a complaint against the fund’s
functioning to the supervisory body
Table 4.4. Risks and instruments in the economic activity of pension funds
Risks Instruments
In the investment process
Low effectiveness Self-regulation through competitive behaviour
Requirement of covering the deficit from the
management company’s resources
Improper policy of investment portfolio diversification Legal requirement to invest in specified financial
instruments
Guaranteed minimum rate of return
Investing in the management company’s own projects
or in recommended investments
A ban or significant restrictions on such solutions
Supervisory actions
Lack of financial liquidity Developed standards of safe conduct
In day-to-day operations
Flow of resources breaking into the fund’s assets for
the benefit of shareholders
Requirement of clear separation of the fund’s and
management company’s assets
Supervisory actions
High costs of fund management Self-regulation through competitive behaviour
Improper valuation of assets Legal regulations on valuation
Supervisory actions

20
transfers premiums to the private pillar (in Poland – the
Social Insurance Institution, ZUS). In the countries of our
region, given the under-development of the capital market
consistent and decisive privatisation of further state proper-ty
is essential.
It seems, however, that in view of most administrative
risks, good regulations and an effective supervisory body are
the essential condition (cf. Table 4.2). The risks of the man-agement
board’s low qualifications and the lack of clear
decision-making rules can be eradicated by defining the con-ditions
that need to be met, especially at the moment when
the fund starts operating. The risk of an imbalance in the
management’s actions for the benefit of fund participants
and management company founders requires constant and
active supervision.
There is also room for the funds to develop standards
[themselves] (e.g. on the issue of the management company
board’s high qualifications). The problem of improper
accounting can be secured by way of obligatory legislative
solutions, but also based on developed standards. The
requirement for an independent audit is conducive to com-pliance
with the principles of reliability.
In the area of social risks, for which Table 4.3 lists the
appropriate instruments, we find mixed solutions. Because
these risks directly concern a fund member, the possibility
of filing a complaint with the supervisory body is a new
instrument not presented earlier. Actions taken on the ini-tiative
of the supervisory body alone do not seem sufficient.
When considering a client’s access to reliable informa-tion,
the decisive instrument will be not so much effective
supervision, but rather a code of ethics and standards of
conduct. If such standards are lacking, it is possible to use
the legal requirement of a state exam to be passed by agents
offering fund membership, which should partly eliminate
persons ill-equipped for the job.
The instruments for economic risks are presented
below in Table 4.4. In this, the last area of the analysis, the
list of risks and instruments is different again. The proper
instrument counteracting a relatively low profitability in
relation to other funds involves, on the one hand, competi-tive
stimuli on the market and, on the other, legal solutions
guaranteeing the interests if insured persons (covering a
deficit in resources from the pension society’s [management
company’s] assets). The reaction to improper diversification
of investment risk can be legal requirements (investment
limits) and effective supervision over the funds’ investment
operations. For the risk involving liquidity of assets, it is suf-ficient
to take advantage of the standards of conduct of
financial institutions that are experienced in operating on the
domestic capital market.
In day-to-day operations, the risk of unjustified transfers
from the fund to the pension society has to be protected by
good legal solutions and effective supervision. It seems that
in the operating costs, self-regulation through competitive
behaviour is an effective tool, especially since cost levels can
be an important element when new participants choose a
pension fund. On the other hand, control of cost levels by
law or through administrative measures would seriously
limit the autonomy of making any kind of decision.
CASE Reports No. 36

21
Part 5
The Practice of Supervision Applied in Other Countries
Introduction
Pension funds, or institutions whose function it is to col-lect
and invest resources securing incomes for old age,
were established earlier than public pension systems. Many
well-known companies created pension systems for their
work force in the early 19th century at the time of the
industrial revolution. By securing their employees’ old age,
employers were implementing a development mission.
With time, when public systems developed widely in the
late 19th and early 20th centuries, occupational pension
schemes became of secondary importance. They became
part of what we call the second pillar. The importance of
occupational pension schemes decreased even more in the
late 20th century. They became part of the third pillar of
securing income for old age. The second pillar is made up of
general capital solutions.
Pension funds today can be found in both the second
and third pillars. These are usually institutions under private
management that invest collected pension premiums. The
premiums are voluntary or obligatory for participants, paid
individually or collectively, transferred to the fund directly
or via some other institution (financial or administrative).
The legal status of pension funds varies. Thus, there are
mutual insurance organisations, closed life-insurance organ-isations,
non-profit organisations, and increasingly frequent-ly
today – joint stock companies. At the end of the 20th cen-tury
there has been a tendency to standardise the legal for-mula
of pension funds. The model for this standardisation is
based on the solutions that emerged in the 1980s and 1990s
in Latin America. Supervision over pension funds is also tak-ing
on a universal character, even though in specific solutions,
there are still differences that grew out of local traditions.
5.1. Experiences of Latin American
Countries
This section, devoted to the region of Latin America,
consists of two basic points. The first provides an overview
of both the development of pension reforms and the provi-sions
applied in their supervision. The second point discuss-es
the institutional aspects of pension supervision in Latin
American countries.
5.1.1. The Development of Pension Funds in Latin
America
Interest in pension funds in Latin America results from
the fact that they are an important aspect of the widespread
securing of income for old age, and in some countries have
replaced the public system. This is therefore not a supple-ment
to expansive, pay-as-you-go public financed systems,
but a segment of the same if not greater importance than
the public segment.
Why is it that, particularly in the countries of Latin
America, the public and pay-as-you-go pension system is
being replaced increasingly widely with a capital-based, pri-vately
managed system? Simplifying the issue a little, one can
point to two important reasons. The first was linked to the
poor condition of public systems, unbalanced and "dam-aged"
by political decisions. As Jose Pi¼era, the author of the
reform in Chile, said, "We built the new system on the ruins
of the old one" (1996). The second reason was linked to the
modernising mission of a new generation of politicians in
Latin America, as pension funds became a source of capital
for the development of domestic investments.
Pension reforms in Latin America went in three direc-tions.
Today we can say there are three new model solu-tions
[Mesa-Lago and Kleinjans, 1997]. The criterion differ-entiating
these models involves the proportions and rela-tions
between the public system (pillar one) and the newly
established pension funds (pillar two).
The first model is a substitutive model. It involves com-pletely
or largely replacing the old system with the new one.
This was the road taken by Chile (1981), Bolivia (1997), El
Salvador (1997) and Mexico (1997).
The second is a mixed model, consisting of introducing
the new segment while diminishing the old one. However,
both segments still exist. This road was taken by Argentina
(1994) and Uruguay (1996).
The third model is a parallel model. This means that
pension funds appeared independently of the public system
CASE Reports No. 36

22
reform. They develop as an alternative, and as competition
for the public system. This was the road taken by Peru
(1993) and Colombia (1994).
Despite the varied methods of reforming the pension
system in Latin America, their common element is the high
degree of universalism in the construction of pension funds
as institutions. As these are privately managed organisations
and at the same time ones replacing a large part of the pub-lic
systems, they are subject to relatively strong supervision.
The choice of reform strategy had a significant impact on
the development possibilities of pension funds. The data in
Table 5.1 show that Argentina and Mexico have the largest
number of currently operating funds (14). The largest number
of fund participants is also in those countries. However, one
has to consider the fact that these countries have relatively
large populations. The calculations in the table show how var-ied
the average number of participants per fund is. The volume
of assets gathered by the funds is greatly influenced by the
degree of a system’s maturity. One case in point is Chile,
where the reform was carried out more than a decade earlier.
The assets of funds operating in Chile account for more than
half the resources amassed in all the countries under analysis.
The funds’ investment policies are mostly determined by
the applicable limits specified by law. On the other hand, the
low degree of development of the capital markets is a strong
limitation.
That is why funds in the great majority of countries in
the region invest mainly in securities issued by the state sec-tor.
Mexico is a typical example, where investments in com-pany
shares are not permitted yet, and close to 95% of
assets are invested in the state sector (cf. Table 5.2). Peru-vian
funds are an exception, as they invest most of their
assets in the company sector. Another significant area of
investment is that of securities issued by financial institutions
(e.g. bank certificates of deposit), accounting for 25% to
over 30% of assets.
Detailed analyses of investment limits show that in
practice, the upper limits set by law are frequently not
reached by pension funds. This is the case, for
instance, in Argentina, Chile and Peru, as illustrated in
Table 5.3.
As can be seen from the figures, restrictions do not nec-essarily
require the aggregated amount to coincide with the
legal upper limit. Also, individual funds usually establish
CASE Reports No. 36
Table 5.1. Latin America: Pension funds in reformed pension systems of selected countries (June 1999)
Country Starting Date Number of
pension funds
Number of
affiliates
(thousands)
Average number
of members in
the fund
(thousands)
Fund assets
(USD
thousands)
Argentina May 1994 14 7,475.2 533.9 13,861.2
Bolivia May 1997 2 448.9 224.5 380.7
Chile May 1981 8 5,996.0 749.5 33,245.9
Colombia April 1994 8 3,181.8 397.7 2,476.0
Costa Rica August 1995 8 113.3 14.2 120.3
Mexico February 1997 14 14,622.2 1,044.4 8,821.9
Peru June 1993 5 2,106.5 421.3 2,082.5
El Salvador April 1998 5 670.1 134.0 118.2
Uruguay September 1995 6 15.0 2.5 476.9
Source: FIAP (1999)
Table 5.2. Portfolio composition in selected countries of Latin America (June 1999)
Country Total State
sector
Corporate
sector
Financial
sector
Foreign
sector
Liquid
Assets
Other
Argentina 100.0 52.8 19.6 25.4 0.3 1.9 -
Bolivia 100.0 66.6 - 29.4 - 4.0 -
Chile 100.0 37.3 18.6 31.6 12.4 0.1 -
Mexico 100.0 94.7 2.7 - - - 2.6
Peru 100.0 6.5 93.3 - - - 0.2
El Salvador 100.0 68.7 - 31.3 - - -
Uruguay 100.0 63.9 6.4 25.0 - 4.7 -
Source: FIAP (1999)

23
Table 5.3. Argentina, Chile and Peru: Comparison of investment limits and actual share of assets (June 1997)
Assets Argentina Chile Peru
(% of fund) actual maximum actual maximum actual maximum
Public-sector bonds 49.3 50 37.7 35/50 11.5 40
Private-sector bonds 4.8 28 3.8 30/50 16.2 35
Certificate of deposit 17.8 28 8.4 30/50 33.6 50
Equities 21.8 35 29.3 35/50 34.8 30
Mortgages 0.4 28 17.0 35/50 0.5 40
Others 5.9 — 3.8 — 3.4 —
Total 100.0 169 100.0 165/250 100.0 195
Source: Rofman, R. and Demarco, G. (1998)
lower-than-legal upper limits of their own, to avoid incur-ring
the costs of asset liquidation when changes in the port-folio
are required. Another reason for the lower-than-legal
limits in Argentina is that the supervisor values the funds,
and, in exceptional cases, this may result in differences
between official prices and those assumed by the pension-fund
managers.
Guarantees
Guarantees in the new pension systems are aimed main-ly
at safeguarding fund members against the risk of the
fund’s bankruptcy, and consequently against the risk of los-ing
their benefit payments. On the other hand, in the case
of people not covered by the fund system (e.g. the poor and
the homeless) or those who will be unable to make a suffi-cient
contribution towards their pension (e.g. the unem-ployed),
the public authorities are organising a system of
other social security measures.
In Chile there are four types of guarantee:
– Those who are not entitled to pension benefits
(including the minimum pension) provided by the mandato-ry
system receive a social allowance in the amount of 12%
of the average wage.
– Those who have a record of no less than 20 years of
service are paid the amount lacking to the minimum pension
if the money accumulated on the individual account is lacking.
– An average investment return is guaranteed.
– Pension benefits are guaranteed if the insurance com-pany
goes bankrupt. The guarantees cover 100% of the
minimum pension and 75% of the sum above the minimum
wage up to a certain ceiling. All guarantees are paid from
one budget, except for the average investment return,
which is secured by pension funds themselves.
If investment return is at least 2% higher than wage
growth, no guarantees are necessary. Problems evolve
when low-paid workers quit to join the informal sector
after paying contributions for 20 years. But ink such cases
only the difference between the minimum pension and the
accumulated money is covered.
Another problem is that 12% of the average wage (i.e.
the social assistance mentioned above) is below the subsis-tence
level, while 25% of the average wage is below the
poverty line. This problem may be solved by offering a high-er
minimum pension for those who have contributed for a
longer period of time, e.g. by paying a fixed amount for all
plus 0.5% for each year contributions were paid.
All Latin American countries with private pension sys-tems
apply a related minimum investment return guarantee.
Each fund must generate a minimum return over a certain
period (usually 12 months) defined as a proportion of the
average return obtained by the pension fund industry. The
management companies (pension societies) are responsible
for compensating fund members if the return is insufficient
(in Argentina and Chile). If the guaranteed return is applic-able
to one year, the investment policy becomes short
term-oriented. At present they are considering an exten-sion
to 3 or 5 years.
When the average investment return is guaranteed, all
pension funds are compelled to behave in the same way. In
addition, one year is too short a period for calculating
returns, as under such conditions volatile funds are
penalised, even though they produce better results over a
longer term, whereas investments which are close to the
permitted level are always profitable but bring lower
returns than the average.
5.1.2. Supervision of Pension Funds in Latin
American Countries
Generally, supervision institutions in Latin America are
devoted entirely to pension funds. This is attributed to the
fact that Latin American pension funds were created after or,
in some cases, at the same time as the supervision agencies.
Comparing supervisory institutions of Latin American
pension funds, one can observe significant differences in
financing and the degree of autonomy enjoyed by the
agency. In three countries the supervision agency has a sig-nificant
degree of autonomy – both in administrative and
political status. These three agencies are financed directly
CASE Reports No. 36

24
by supervised pension companies, through the payment of a
fee. At the other extreme, the agencies in Colombia and
Uruguay are a department of the Central Bank. Chile is a
halfway house, since the supervisory agency is separate
but with (administrative, political and financial) depen-dence
on the ministry of labour and social security (cf.
Table 5.4).
However, not only pension supervisory institutions
oversee this industry. As it belongs to the larger finan-cial
sector of the economy, it is supervised by other
institutions as well. For example, in Chile there are
four institutions which have say in the industry: the
Superintendencia de Administradores de Fondos de Pen-siones;
the Superintendencia de Valores y Seguros or
Superintendent of Securities and Insurance; Central
Bank of Chile; and the Risk Rating and Classification
Commission.
In Uruguay all financial institutions are supervised by
the Central Bank. In Argentina the Superintendencia de
Administradores de Fondos de Jubilacion y Pensiones is
joined by the Superintendent of Insurance, the Superin-tendent
of Banking and the Superintendent of Securi-ties
at equal levels, along with the Central Bank, the
Inland Revenue Bureau and the Department of Social
Security.
Performance of supervision institution
Table 5.5 presents several features of currently operat-ing
supervisory bodies from the point of view of their effec-tiveness.
The Mexican supervisory institution is the largest of the
seven agencies, at least in terms of the number of employ-ees.
But this reflects differences in the number of affiliates to
pension funds (see Table 5.1) – over 14 million employees
are covered in Mexico, compared with more than 7 million
in Argentina, 6 million in Chile, 3 million in Colombia, just
over 2 million in Peru and fewer than half a million in Bolivia.
Consequently, Mexico’s employee-to-fund-member ratio is
the second lowest after Colombia. The very high ratios in
Bolivia and Uruguay probably result from the relative youth
of their systems and the small number of pension-fund
members, which may cause problems due to a lack of scale,
whereas the high ratio in Peru may indicate inefficiency.
The ratio of the budget to the revenues flowing into
funds is less distorted. This measure shows how much of
workers’ contributions go to finance supervision (in systems
where fees pay for supervision). Because the supervision
agencies in Colombia and Uruguay are part of the Central
Bank, it is unfortunately not possible to isolate their budgets
from that of the parent institution. On this measure, the
CASE Reports No. 36
Table 5.4. Institutional characteristics of pension-fund supervisory agencies in Latin America
Country Area of government Administrative and Political
Independence
Funding source
Argentina Ministry of labour and social security Autonomous Supervision fee
Bolivia Treasury Dependent Supervision fee
Chile Ministry of labour and social security Dependent National budget
Colombia Central Bank Dependent Supervision fee
Mexico Treasury secretary Autonomous Supervision fee (partial)
Peru Ministry of the economy Autonomous Supervision fee
Uruguay Central Bank Dependent National budget
Table 5.5. Latin America: Performance of Supervisory Institutions in Selected Countries
Country Employees Budget Employees/
fund members
Employees/funds Budget/
funds’
assets
Budget/
funds’
revenue
number $ million per million number % %
Argentina 183 12.5 30.5 10.2 0.14 0.36
Bolivia 21 1.9 63.9 10.5 1.80 1.80
Chile 134 7.0 23.2 10.1 0.02 0.28
Colombia 30 — 11.9 3.3 — —
Mexico 214 26.3 19.1 12.6 0.42 0.95
Peru 85 5.1 73.9 14.2 0.34 1.23
Uruguay 21 — 45.7 4.2 — —
Note: Bolivia: budget/funds and budget/revenue are equal because the figures cover only one year of operation. The figures exclude the
Bonosol/Bolivida programme

25
cheapest agencies are those in Chile and Argentina, which
spend between 0.25% and 0.50% of total revenues. The
ratio of employees to the number of operating pension
funds appears to be the most consistent indicator. Its value
is close to 10 in most cases. The exceptions of Colombia
and Uruguay reflect the fact that supervision is a part of the
Central Bank, and so support services are part of the larger
organisation and outside the supervision agency.
5.2. Experiences of Selected OECD
Countries*
Pension funds in the OECD countries were established
much earlier than pension funds in the Latin American coun-tries.
Table 5.6. Pension fund assets and benefits paid in selected countries
Country Fund assets as %
They developed along very different tracks and no
tendency to unify them is visible today. However, one can
identify a group of countries where pension funds are
widespread or much more popular than elsewhere.
These are where occupational pension schemes have
been made mandatory. This is the case in Switzerland,
Denmark, the Netherlands and Australia. One must also
mention Sweden, which in 1998 significantly reformed
the public pension system and introduced an obligatory
capital segment into it, to which a mandatory premium of
2.5% is paid.
In the other countries, participation in capital pension
funds is not obligatory, but they are so popular that they are
a significant element of securing income for old age. These
countries include the United States and the United King-dom.
Pension funds are also relatively popular in Belgium.
5.2.1. Activities of Pension Funds in Selected
OECD Countries: the Comparative Perspective
As we have said, pension funds can have one of several
legal formulas.
The legal structure of the private pension provision may be:
– Bank or insurance company,
– Management company, or
– Foundation/ trust/ mutual fund.
Pension fund assets may be wholly segregated, or min-gled
with other investors or asset managers.
Most countries require entire segregation of the assets
belonging to pension funds either from the sponsor
(employer) or management company. The pension fund can
be set as a trust (Anglo-American countries), a founda-tion/
mutual fund (European Countries) or a management
company (Latin American countries). A book reserve sys-tem
and accounts in financial institutions allows conjunction
of assets.
Table 5.7 shows the diverse range of valuation methods
used in OECD countries.
In Hungary, book value for assets valuation is used.
Unrealised capital gains are not included. Assets value is
recalculated quarterly at market prices. In Switzerland
there is no insistence on valuing assets at market prices,
therefore it is possible to manipulate prices. Artificial sales
and purchases of shares occur in order to realise capital
gains. Manipulation of returns in order to meet the estab-lished
minimum is also possible in this way.
Most of the countries have adopted formal accounting
standards – FAS 87 in the US, SSAP 24 in the UK, BiRiLiG in
Germany – which are also used in pension fund accounting.
The problem of funding arises only for defined benefit
(DB) pension plans. They may be fully or partly funded.
Some countries impose minimum funding requirements in
* Chapter 5.2 is partly based on materials provided by Audrone Morkuniene, from the Lithuanian Free Market Institute.
CASE Reports No. 36
of GDP
Share of pensions from PF as
% of all retirement benefits
Working population
covered
Belgium 4.0 8.0 31%
Denmark 60.1 18.0 80% [1]
The Netherlands 88.5 32.0 90%
Switzerland 70.0 n.a. 100%
Sweden 74.0 n.a. 90%
United Kingdom 79.4 28.0 50%
Australia 39.0 n.a. n.a.
United States 66.0 n.a. 46%
Source: European Commission (1997) and OECD (1998 a, b). For working population: Laboul (1999), p. 30
Note: [1] - Regarding to employees only

26
Table 5.7. Valuation bases in OECD countries
Country Equities Bonds Loans Property
Quoted Unquoted High quality Low quality
Belgium market market repayment mkt/purchase outstanding market
Denmark mkt/purchase mkt/purchase amortised amortised amortised mkt/purchase
Ireland market market market market market market
Netherlands mkt/purchase mkt/purchase mkt/purchase mkt/purchase mkt/purchase market
Sweden mkt/purchase mkt/purchase mkt/purchase mkt/purchase mkt/purchase mkt/purchase
Switzerland adjusted market adjusted market amortised amortised market —
United Kingdom market adjusted market market market market Market
Australia market market market market market market
United States market market amortised mkt/purchase mkt/purchase mkt/purchase
Note: ‘mkt/purchase’ means the lower of either the market or purchase price for quoted investments and the lower of the purchase price or writ-ten-
down book value for unquoted. Belgium: repayment value used for securities issued or guaranteed by the public sector; the lower of the market
or the purchase value applies to other high-quality bonds. Finland: mortgages are amortised, while other loans are adjusted to market value. Nether-lands:
bonds and loans can also be valued on an amortised basis. United States: data apply to New Jersey and Delaware
order to enhance the security of pension promises. Defined
contribution (DC) schemes are fully funded by their nature.
In tax privileged DB schemes the problem of overfund-ing
– and not only insufficient funding – may arise. Govern-ments
are usually concerned not to allow too high tax sub-sidies.
Many OECD countries – Australia, Belgium, Germany,
Italy, Japan, Sweden and Switzerland – also set portfolio lim-its.
In other countries, such as Canada, Denmark, Ireland,
the Netherlands, the United Kingdom and the United
States, there are no quantitative restrictions. However, pen-sion
funds are obliged to invest as a ‘prudent person’ would
with his or her own money.
Most of countries have some type of limits on possible
pension fund investments.
The actual structure of investments is shown in Table
5.8. It shows there is a significantly varied approach. Beside
countries with a large degree of boldness in investing in
CASE Reports No. 36
Table 5.8. Portfolio distribution of pension funds in selected OECD countries
Country Equities Private
bonds
Public
bonds
Loans Other Investments
abroad
Australia
(1)
27.0 20.0 n.a. 39.0 n.a.
Denmark 7.0 56.0 11.0 7.0 19.0 -
(2)
Ireland
57.0 n.a. n.a. n.a. 7.0 n.a.
Netherlands 30.0 4.0 19.0 43.0 6.0 15.0
(1)
Sweden
1.0 84.0 n.a. 14.0 n.a.
Switzerland 16.0 29.0 22.0 33.0 -
United Kingdom 63.0 3.0 11.0 - 23.0 18.0
USA 46.0 16.0 20.0 2.0 16.0 4.0
Source: World Bank (1994) p. 374, Davis (1993)
Notes: (1) For Australia and Sweden Bodie, Michell and Turner (1996). (2) For Ireland: OECD (1998 a, b)
Table 5.9. Simulated rate of return to private pension funds in selected countries: 1970 – 1990
Country 1970 – 75 1975 – 80 1980 - 85 1985 - 90 1970-1990
Denmark -2.0 0.8 16.9 - 4.1
Netherlands -1.5 1.9 10.4 6.2 4.2
Switzerland -1.4 3.7 2.7 -0.2 1.2
United Kingdom -0.5 5.0 12.4 8.0 6.1
USA -1.6 -2.0 7.7 9.6 3.3
Source: World Bank (1994), Davis (1993)

27
more risky instruments (United Kingdom, Ireland), there
are many examples of a moderate or even clearly conserv-ative
policy.
As regards the profitability, the rate of return of pension
funds varied substantially not only between countries, but
also in time spans (cf. data in the Table 5.9). The latter
demonstrates how much pension funds depended on finan-cial
markets. On the other hand, the size of pension funds
Table 5.10. Vested rights in selected countries
Country Entitlement of vesting rights Transfer modalities
Belgium Immediate on employee contribution
affected the structure of financial markets. Countries with
large funded schemes tend to have developed securities
markets, while in countries with small pension fund sector
capital markets are relatively less developed [Blommestein,
1998].
Data covering the period 1967–90 seem to support the
argument on differences in annual rates of return on pen-sion
fund investments between countries with prudent-per-son
rules compared with those with quantitative limits. The
first group gained relatively higher returns; more recently,
the difference in returns between the two groups widened
from 2.6 percentage points in 1984–93, to 4.3 in 1984–96
[Blommestein, 1998].
Despite the fact that most OECD countries have DC
schemes, under which all risks are taken on by the employ-ee,
they do not impose a guaranteed investment return
requirement. There are "guaranteed investment contracts"
at insurance companies and "guaranteed deposit contracts"
at commercial banks, promising interest lower by half than
one-year government securities.
Contribution holidays are permitted in the event of sur-plus.
Statutory surpluses may be refunded subject to a num-ber
of conditions, including indexation of present and future
pensions.
Vested rights and portability differs significantly across
countries, posing serious obstacles to the portability of pen-sion
rights between distinct pension schemes and countries.
In certain countries the requirements are very strict. The
vesting period is one year of service in Belgium; in Denmark
– 5 years or age 30, whichever is the earlier; in Spain –
immediate; in Ireland, 5 years; the Netherlands – 1; the UK
– 2 years; Switzerland – immediate vesting of minimum
benefits; Germany – age 35 or 10 years of service; and Lux-embourg
– from 5 up to 10 years.
Payments from pension funds may be in the form of
annuities, periodical withdrawals or a lump sum. Some
countries allow only annuities. Lump sum payments are usu-ally
restricted.
The indexation of private pensions is very rare. It can be
applied both to pension benefits in payment and deferred
CASE Reports No. 36
1 year on employer contribution
Transferability of vested reserves
Denmark Immediate Possibility of transfer of surrender value
between occupational pension schemes
Netherlands 1 year Possibility of transfer, under same conditions,
within large network of pensions
Sweden (ATP) Immediate Full transferability of national plans
Switzerland Immediate for minimum contribution -
United Kingdom 2 years Transfer to the pension funds
United States 5 years Possibility of lump sum in case of transfer
Source: Laboul (1999), p. 33
Table 5.11. Indexation in private schemes in selected OECD countries
Country Existence/ Legal status
Belgium No indexation but possible adjustments
Denmark No mandatory indexation, but usual in practice by allotment of bonus
Ireland Indexation usual in practice
Netherlands No mandatory indexation, but usual in practice
Sweden Indexation
Switzerland Optional indexation
United Kingdom Benefits indexation
United States Discretionary indexation
Source: Davis (1995), Laboul (1999)

CASE Network Report 36 - Rational Pension Supervision.First Experiencies of Central and Eastern European States in Comparison with Other Countries

CASE Network Report 36 - Rational Pension Supervision.First Experiencies of Central and Eastern European States in Comparison with Other Countries

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CASE Network Report 36 - Rational Pension Supervision.First Experiencies of Central and Eastern European States in Comparison with Other Countries